Dollar Tree gapped up this morning on news of a great second quarter earnings report:

The first candle was wide range and although it closed up strongly, it left a rather long upper wick (red circle). The gap up and expansion in price were both on unusually high volume. The next candlestick was narrow range and it also closed up. Notice that trading activity dried up suddenly as price contracted.

But for some reason I didn’t really like the upper tail on the first candle and allowed it to persuade me to not take the trade as price broke above the second candlestick’s high (green line). I surmised that with price having been pushed back at those levels before, it might be again. This made me believe that the risk to reward wasn’t high enough to merit entering the trade (red line).

In hindsight of course, I should have entered long. As a discretionary trader, hindsight can be rather dangerous. After all, I can only apply my edge and wait for probability to give me the results.

One of the most important attributes of great traders is the selection of trades based on risk to reward. Tony Oz, for example, mentions that he will not take a trade unless he spots a 1:3 risk to reward ratio. Of course, there is no guarantee that once you take the risk a reward will be forthcoming - at all or in that proportion.

Yet, to maximize profitability (rather than making your broker rich), you should only participate where the size of the possible reward significantly outweighs the size of the risk.

And in the case of Dollar Tree today, with the R being $0.22 and potential resistance being less than 1 R away from entry… it just wasn’t worth the risk.

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